Treasury Debt and the Pricing of Short-Term Assets

Abstract

Since the 2008 financial crisis, the supply of short-term debt from the Treasury has been increasingly associated with changes in the yields on short-term money market assets. This puzzling pattern contrasts with the pre-crisis experience and raises questions about the Fed’s ability to fulfill its mandate. In this paper, I document and rationalize these developments in an intermediary asset pricing model with heterogeneous banks subject to a liquidity management problem and regulation. The combination of large amounts of excess reserves and a more stringent capital regulation prevents traditional banks from intermediating liquidity to shadow banks. As a consequence, the pricing of reserves disconnects from the pricing of other short-term assets. The liquidity premium of these assets is then free to react to variations in the supply of Treasury bills. The quantitative model accurately predicts post-crisis variations in Treasury bill and repo yields, as well as in reverse repo volumes from the Fed.